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Does Racial Wealth Disparity Hinder Entrepreneurship?

Entrepreneurs of color are underrepresented and continue to have lower rates of entrepreneurship than their white counterparts. As race plays a large factor in wealth inequality; does this put potential entrepreneurs of color at a disadvantage related to starting a new business?

A paper by Ross Levine and Yona Rubinstein examines the unique traits of entrepreneurs to help answer the question of who becomes an entrepreneur. The paper shows that entrepreneurs tend to be “white, male, and come from higher-income families.” But why does family wealth contribute to an individual’s likelihood to become an entrepreneur? The answer: capital.

A 2011 Pew Research Center study shows “the median wealth of white households is 20 times that of black households and 18 times that of Hispanic households.” Another study by the Institute on Assets and Social Policy (IASP) suggests that two of the primary sources of wealth disparity found in the Pew Research Center study include homeownership and “inheritance, financial supports by families or friends, and preexisting family wealth.”

Capital matters for those starting businesses for a variety of reasons. A business that starts from a strong financial position is more likely to be able to scale based on opportunities that arise and adapt to challenges. Startups with more initial funding are also more likely to receive additional sources of funding during financing rounds. For many Americans, capital is created through homeownership and family assets.

Homeownership

The IASP study shows homeownership is a factor in racial wealth inequality in several ways.

First, through family contributions as whites are more likely to receive inheritances or other monetary support from family for down payments. While “almost half of white Americans got money from a family source for a home down payment,” nine in 10 black Americans have no family financial assistance for their down payments. As a result, “white families buy homes and start acquiring equity an average eight years earlier than black families.” Due to the family monetary contributions, white homeowners can contribute a larger down payment which lowers interest rates.

Second, through homeownership rates. “Due to historic differences in access to credit, typically lower incomes, and factors such as residential segregation, the homeownership rate for white families is 28.4 percent higher than the homeownership rate for black families.” While people of color tend to have lower rates of homeownership, it remains a bigger proportion of their wealth compared to their white counterparts (53 percent for people of color compared to 39 percent for whites).

Family Contributions

The disparity in family contributions exacerbates wealth disparity. Millennials have been delayed in securing full-time employment and being financially self-sufficient compared to previous generations. During the downward trend, white Millennials in particular are more likely to receive family monetary assistance in the form of formal gifts, like inheritance, and informal gifts, like parents paying for their children’s health insurance or phone bill. Meanwhile, Millennials of color, who have less accumulated wealth, are more likely to share their savings with their family members, diminishing even further their amassed wealth.

Whites are more than five times as likely to receive an inheritance as blacks (36 percent vs. 7 percent). For those “receiving an inheritance, whites received about ten times more wealth than African-Americans.”

In the IASP study, which followed families over a 25 year period, white families were more likely to be able to use their inheritance to continue to amass wealth. The study showed “each inherited dollar contributed to 91 cents of wealth for white families compared with 20 cents for African-American families.” This is due to a variety of factors, including white families not needing to dip into the inheritance money in emergencies, due to their larger initial wealth.

An article in The Atlantic sheds light on a study from the Journal of Economic Perspectives that shows that “as much as 20 percent of wealth can be attributed to formal and informal gifts from family members.”

The Atlantic article highlights that white Millennials are more likely to receive financial assistance from their family. In contrast, nearly “80 percent of black parents and 70 percent of Hispanic parents expect to be supported” by their children. A main reason “why people of color are unable to save as adults is because they give financial support to close family.”

Wealth accumulation serves two purposes for potential entrepreneurs. First, they are able to use their wealth to finance their startup venture. Second, it impacts their risk assessment.

Startup Funding

For most entrepreneurs, funding is seen as a critical component to the success or failure of their startup. More than two-thirds of entrepreneurs use personal savings as a source of funding and more than one-in-five rely on family for funding. For Millennials, 22 percent say they used “a financial gift or loan from their family to fund their start up” and 10 percent used a “financial gift or loan from their family to run their business after the launch phase.” With the large racial gaps related to the ability of an aspiring entrepreneur to rely on their personal savings or their family to supplement startup funding, potential entrepreneurs of color are at a disadvantage in being able to fund their ventures.

Reducing Risk

White entrepreneurs also have more financial padding to take a risk, like starting a new business. As mentioned in a previous Growthology post, “one way to support entrepreneurship is to provide a social safety net that can help an entrepreneur take the risk of starting a new business.” According to The Atlantic article, “95 percent of African American and 87 percent of Latino middle-class families do not have enough net assets to meet most of their essential living expenses for even three months if their source of income were to disappear.” People of color do not have the assets to take the risk of entrepreneurship, to quit their job, and bet on a new idea.

Another paper by Eric G. Hurst and Benjamin W. Pugsley suggests that people who own a business often make less than they would if they externally employed, but choose to own their own business because of non-pecuniary factors including wanting to be their own boss, flexibility, and following their passions. Therefore, “owning a business [could be considered]…a relative luxury good.” Because choosing to start your own business might mean lower career earnings, those with less wealth accumulated may be dissuaded from starting their own business. Their priorities can be more focused on career choices that weigh pecuniary advantages over lifestyle ones.

Research suggests a variety of reasons why different racial groups become entrepreneurs at different rates. Some researchers cite the continuing impact of slavery on black Americans’ ability to accumulate wealth. One paper by Vicki Bogan and William Darity, Jr. proposes that “many immigrants have resources (not available to native non-Whites) that facilitate entrepreneurship.” In fact, the authors conclude that during the period of time they studied (1910-2000) black immigrants “maintain higher rates of self-employment than native Blacks.”

Wealth accumulation has been shown to impact who becomes an entrepreneur, primarily due to the importance of startup funding. As we continue to encourage underrepresented groups, including people of color, to become entrepreneurs, it is important to better understand and mitigate the underlying economic factors that make it harder for them to enter and compete in the entrepreneurial landscape.